MCI-Communications-Corp.--1983

1、MCICOMMUNICATIONSCORPORATIONIntroductionIn1982,theJusticedepartmentorderedtheseparationofATTintolocalsubsidiaries.MCIwasoneofthemaincompetitorsofAT&TandtheimpactofthisnewcompetitiononMCIwasuncertain.Inthiscasethefinancialimpactofthisincreasedcompetitionwillbeanalyzed.AnalysisofExternalFinancingNeedsforMCIfrom1983to1989PleaseseeExhibit1andExhibit2MCI’sexternalneedswillkeepincreasingoverthenextfewyearsastheoperatingmarginswouldshrinkbecauseofhighercompetition&higheraccesscharges.Inordertoincrease。

2、itsmarketshare,MCIwouldneedtocontinueinvestinghugecapitalsinitsnetwork.Asperexhibit9ofthecase,itisanticipatedthatMCIwillincreaseitsmarketshareto20%inthenext6years.Thetelecomindustryisverycapitalintensiveandin1983required$1.15worthofinvestmentinfixedplant&equipmentforeachextra$1ofrevenue;thatisfirstyouhavetobuildthenetworkbeforeyoucansignupcustomers.Theoperatingmarginisexpectedtostabilizeat15%by1990.Buttheyareexpectedtovarysubstantiallybasedoncompetition.Itcangoupto22%orgodownto8%.Typesofsecuriti。

3、eswhichwereissuedbyMCI(1972-1983)1.CommonStock2.CommonStockwithwarrant3.Convertiblecumulativepreferredstock-CostAround12.274.Debentures–Costaround15%5.Convertibledebenture–costaround10%MCIinitiallyissuedequityin1972andlateritstartedissuingdebentures&convertibledebentures.Thiswasbecausethecostofequityishighest.MCIreliedondebenturesforawhileandthenconvertibledebentureswhichhadlowercostofcapital.Asitsequitystockpricecontinuedrising,itconvertedtheconvertibledebenturestocommonstocktherebyincreasingit。

4、sequity&loweringitsliability.ThisallowedMCItoraisefurthercapitalinthefuture.TheconvertiblebondsprovidedacosteffectivewayforMCItofinanceasequenceofmajorcapitalinvestments.ItallowedMCItomatchcapitalinflowswithexpectedinvestmentoutlays.OncethestockpriceroseMCIforcedtheconversionand1/4eliminatedthecashflowdrainfromservicingthedebt.Thenewinfusionofequitycaninturnbeusedtosupportadditionaldebtorconvertiblefinancing.Forexample-oMCIissued100millionconvertibleofferingin1981withaconversionpriceof12.825whil。

5、ethecurrentpriceatthattimewas10.875.oByFeb’1983,thestockpricehadgoneabove12.825andMCIcalledforconversion.Itreduceditsleverage.oItusedthisnewinfusionofequitytoraise$400millioninthenewconvertibleofferingatconversionpriceof$52.ThisstrategyworkedforMCIbecauseitwasunabletosatisfyitsdemandforhugecapitalfromtheinvestmentgradebondmarkets(ithadnoprevioustrackrecord)orfromregularbanks.Raisingmoreequitywouldhavedilutedthevalueforexistingshareholdersandthecostofequitywouldhavebeenveryhigh.Theconvertibleoffe。

6、ringswereacceptedbyinvestorsatalowercouponthanstraightbondsbecausetheycouldgetcapitalappreciationiftheMCIstockpricegoesup.AnalysisofHistoricalandProposedCapitalStructureInApril1983,thetelecomindustrywasgoingthroughmajorregulatorychanges.AT&Twasbeingdividedintosmallercompaniesandequalnetworkaccesscostswerebeingestablished.MCIhadagoodopportunitytoincreaseitsmarketshare.PleaseseeExhibit3fordetailedanalysisofHistoricalandProposedCapitalStructure.Italsofacedseverefinancingchallenges.oRaisingmoreequit。

7、ywouldhavedilutedthevalueforexistingshareholdersandthecostofequitywouldhavebeenveryhigh.oRaisingdebtfromtheinvestmentgradebondmarketswasnotfeasibleasithadahighleverageof55-60%anditalsodidnothaveaprevioustrackrecordinthebondmarket.oIthadalreadyexhaustedmostofthelinesofcreditwithcommercialbanks.oItwasusingconvertibledebentureofferingssequentially,toraisecapitalandinfuseequityatapointinfuturebyforcingconversion.Basedontheabovepoints,IrecommendthatMCIshouldcontinuetomaintainitshistoricalcapitalstruc。

8、tureof55–60%debt.RiskwithMCI’sCapitalStructureTheriskwiththisstructureisthatinfaceofincreasingcompetition,itshighleveragewilllimititsstayingpower.Increasingcompetitionmayleadtoexcesscapacityandtherebydecreasingtheprofitpotential.Insuchascenariothevalueofbondswilldropsharplyandcostofborrowingwillgoupsignificantly,makingitverydifficulttoraisenewcapital.SoevenifMCIhasaverysolidstrategyforcompetingagainstAT&T,itsgrowthmaybeseverelyrestrictedduetocapitalconstraints.2/4MCIstillhadtomaintainitscurrentc。

9、apitalstructure,in1983,becausethebondmarketswerenotreceptivetospeculativecompanies.Asperexhibit8ofthecase,itdoesnothaveabondratingatthistime.TheconvertiblebondofferingsallowedMCItoraisecapitalnowandconvertittoequityatalaterstage.Itsinterestcoveragein1983is4.2,incomparisonto3.64AT&Tand2.4forGTE.Afterithasincreaseditsmarketshare,MCIcanthenstrivetogaininvestmentgradestatusbyslowlyreducingitsleverage.AnalysisofFinancingAlternativeFinancingOptionforMCIin1983CurrentstockpriceinApril1983is$47.Pleasesee。

10、Exhibit3foranAnalysisofFinancingAlternativeFinancingOptionforMCIin1983(a)$400MillionCommonstock–oThisoptionwouldbethecostliestfortheCFOofMCI.Raisingmoreequitywoulddilutethevalueforexistingshareholdersandthecostofequitywouldbeveryhigh.oPleaseseeExhibit3.(b)$500millionof12.5%20yearsubordinateddebentures–oCostofdebtinthiscaseis12.5%thoughMCIcanraise$100millionmorewiththisoptionincomparisontooption(a)above.Servicingthisdebtwouldbeasignificantdrainonthecashflow.oPleaseseeExhibit3.(c)$600millionConvert。